Saturday, July 18, 2009

The Problem With Medians

Prices, vacancy rates, rents - most pronouncements of real estate trends are the medians of a set of data. These reports are largely meaningless, or, even worse, actively misleading. Lansner on Real Estate’s post “Is Median Price Giving Bum Signals?” quotes John Burns, and Orange County housing consultant, on the subject:

We are extremely concerned that policy makers, banking and real estate industry executives, investors and others will use misleading home price data to conclude that home prices have stabilized. They have not. These same influencers used this data in 2006 and 2007 to make decisions, many of which have proven to be poor decisions. It was a tough lesson, and hopefully one that won’t be repeated. This is a complex issue. Here is why: Reported home prices and home price indices rely on a small sample of transactions that represent far less than 1% of the owned homes in an area.

The data problem is serious for homes, and exponentially worse for commercial real estate because there are even fewer transactions. The problem is an ongoing theme over at Calculated Risk; see “Misleading Housing Price Data” and “Median Price Mix Example”, for example.

An alternative is the “same store” trend, which compares sales prices and operating data from the same property over time. The problem with using this approach for commercial real estate is that property and price performance are idiosyncratic. For example, land values can change radically as a result of permits being obtained or a local building moratorium being imposed. The loss of a major tenant can have a big impact on the value and operating data of an office or retail property. A new, incompetent property manager in a multifamily property can cause a big spike in vacancy. There are so many micro factors which can influence prices and performance that in my opinion it’s very difficult to draw macro market conclusions from the relatively small samples we have to work with. 

Certainly we can identify major sustained trends, but if some told me their data showed office values are down 30% in a market, my conclusion would be prices are down somewhere between 15% and 45%.

What’s the solution? When it comes to commercial real estate, I don’t think there is one – there are just not enough transactions to draw meaningful conclusions.  Employment trends provide a good proxy for commercial real estate performance; I’ve yet to see a real estate market getting better when the market is losing jobs. I’ll believe CRE and residential markets are getting better when we start seeing employment growth again.